Can loan be earmarked as coming from the employer matching contributio

[Richard Anderson]

A participant has $2,000 in deferral account and $1,000 in matching account. He is 20% vested in match. If the plan's loan policy allows the participant to choose from what source the loan will come from, can the participant have a $1,000 loan come from the match source only? If the participant terminates and defaults on the loan, the plan can forclose on the deferral account to restore the unvested portion of the match account that was loaned to the participant.

[pjkoehler]

You've got two issues here. First, satisfying the exception to avoid treating the loan as a distribution under Code Sec. 72(p)(2)(A). Second, satisfying the exception to avoid a prohibited transaction by providing that the loan is "adequately secured." ERISA Sec. 408(B)(1). The $1,000 loan satisfies the limit set forth in Sec. 72(p)(2)(A)(ii), not taking into account any prior loan balances. But, a participant's vested matching account balance will be adequate security for the loan to the exent of the plan's ability to satisfy the loan's outstanding balance in the event of default. DOL Reg. Sec. 2550.408b-1(f)(1). Accordingly, if the plan's loan policy provides that the loan may only be secured by the participant's vested matching account balance ($200 in your example), you will not have satisfied the statutory PT exemption for a $1000 loan, unless the participant pledges additional security. A little understood rule is that, even though for Sec. 72(p) purposes in determining the amount of the loan, an account balance of $10,000 or less will support a loan amount equal to 100% of the account balance, for PT exemption purposes, no more than 50% of the vested account balance can be used for meeting ERISA's "adequately secured" requirement. DOL Reg. Sec. 2550.408b-1(f)(2). So the maximum loan for the employee you've described, where the loan policy limits the security to the vested matching contribution, is only $100 (50% of his vested account balance). While the loan policy may limit the loan amount to the entire matching account balance, which would theoretically permit him to obtain a $1,000, he's going to have to provide collateral in addition to his vested matching account in order to secure $900 of the loan. Allowing participants to secure their loans with property other than their vested interest is usually not administratively feasible for any but the largest plans.

[Richard Anderson]

Why can't the other $900 collateral be from the deferral account? He borrows the full $1,000 from the match account, and secures it with 50% of the deferral account.

[IRC401]

I assume that your objective is to have an

actual, as opposed to a deemed, distribution

in the event of a default.

You can write the plan so that you use the entire

vested interest as security and list the order

in which accounts will be collateral if there is a

default. If there is a default before the vested

interest in the matching account exceeds the loan

balance, you would still have a deemed distribution.

Remember that there is an ancient rev rul that profit-

sharing contributions must be in the plan for at least

two years before they can be distributed. Therefore,

using the matching account may not solve the deemed

distribution problem.

I offer no opinion whether you can do what you want through

a prototype plan or how hard it will be for your recordkeeper.

[Kirk Maldonado]

IRC 401 is correct about the ancient Revenue Ruling. However, I seem to recall that if the participant has been in the plan for at least for five years, then all amounts can be distributed, even amounts that have been in the plan for less than two years.

[pjkoehler]

I think what you are saying is that the loan policy does or should permit the participant to have a $1,000 loan "from the match source only," and secure that loan, which then becomes an interest-bearing asset of the matching contribution account, by pledging a $100 security interest in the matching account and a $900 security interest in his deferral account. Sounds ok, but it's kind of unusual and you'll need special language in the note and security agreement to satisfy the "adequately secured" PT exemption.

Except in the case of a principal residence plan loan, the adequacy of the security is not a requirement for avoiding a "deemed distribution." A loan is treated as a "deemed distribution" because it violates one of the requirements set forth in Code Sec. 72(p)(2) in form or operation. For example, the failure to make a scheduled payment by the end of the loan policy's grace period violates the "level amortization" requirement in operation. See Prop. Treas. Reg. 1.72(p)-1, Q&A-3. A loan that satisfied the exemption requirements under Code Section 72(p) at origination and continued to be a fully performing asset (no defaults) is not a "deemed distribution" merely because it ceases to be "adequately secured" before it is repaid. Theoretically, this could happen if the participant's plan account experiences significant unrealized depreciation.

[Edited by PJK on 07-17-2000 at 02:17 PM]